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Important Year-End Tax Implications For Ranchers

When it comes to tax planning for this year and next, here’s the only thing that’s certain – you will get to pay. Beyond that immutable fact, however, the only thing certain about the current state of tax policy is its uncertainty.

If Congress doesn’t act before year’s end, federal tax increases will go into effect on Jan. 1. That will raise rates on virtually all taxes for all taxpayers, including income, capital gains, dividends, wages, gifts and estates.

The most likely scenario, according to Roger McEowen, director of Iowa State University’s Center for Agricultural Law and Taxation, is that Congress will wait until early 2013 to make any changes in the tax code. “I think it will come in January and be on a retroactive basis, which is nightmarish from a tax-planning standpoint.”

The problem, says Rob Gunther, a CPA and ag tax expert with Frost PLLC in Little Rock, AR, is that many of the 2010 Tax Act provisions that expire on Dec. 31 will directly affect farmers and ranchers.

Potential estate tax changes

Estate taxes are a good example. For 2012, decedents’ estates have to pay estate tax on amounts above $5.12 million at a top rate of 35%. The exemption is scheduled to revert to $1 million in 2013, however, and the top rate will increase to 55%.

Which is why, Gunther says taking steps before the end of the year to manage your estate taxes is critical.

“The 2010 Tax Act increased the ability to transfer $5 million of wealth ($10 million for a married couple) from one generation to the next,” Gunther says. “We’ve never had this opportunity before.”

Generally, estates valued at more than $10 million for a married couple will benefit, he says. Given escalating ag land values, you may be closer to that high-water mark than you think. “I think there are more people in that position than take the time to consider it. It doesn’t take very long to get there these days.”

However, gifting cash isn’t your best move, he cautions. “What you want to consider giving away are assets that are highly appreciating; any closely held business interest is generally where most appreciation occurs.”

Nearly any type of business structure can facilitate the gifting of closely held business interests. You don’t have to give the whole amount, Gunther says. It can be any amount you want.

Nor do you have to worry about giving up control of the operation. Non-voting stock or different classes of LLC units may be used. And both you and the beneficiaries can take advantage of various discounts that can be applied to the stock’s value.

Those discounts, which include lack of marketability and lack of control, can range from 20-40%. “So say you have $10 million of actual value. After the discounts are applied, you may only have $6 million, so in reality, you’re actually moving much more than meets the eye,” Gunther says.

If you and your CPA determine that your estate isn’t large enough to take advantage of this opportunity, Gunther says you may be better served to let your assets pass through your estate when you die because your children will get a stepped-up basis on those assets.

“Basically what that means is any real asset that passes through your estate will wind up in your children’s hands with a basis equal to the market value at your date of death,” Gunther says.

If Congress doesn’t act on taxes this year, the exemption will decrease to $1 million on Jan. 1. However, Gunther doesn’t expect it to stay there. “Some proposals include bringing the exemption back to $3.5 million,” he adds, which is where it was previously. But even if that happens, you’re potentially leaving a $1.5-million exemption on the table if you wait until next year, he cautions.

Section 179 bonus depreciation

Last year, producers took advantage of significant bonus depreciation and Section 179 deductions. Those deductions are available in 2012, but at reduced rates. For 2013, they’re reduced even further.

The bonus depreciation allows writing off 50% of the cost of a depreciable asset this year and the remaining 50% over the prescribed life of the asset. “This is available only on new property (such as machinery) and any taxpayer can take advantage of this,” Gunther says.

The deduction is basically for equipment and allows you to expense up to $139,000 in 2012 on equipment purchases up to $560,000, with a dollar-to-dollar reduction in the amount that can be expensed for each dollar between $560,000 and $699,000, McEowen says.

Beyond that, McEowen says capital gains taxes, dividend taxes and taxes on ordinary income are set to increase in 2013. Capital gains, which were taxed at a maximum 15% for taxpayers in higher brackets, will increase to 20% for higher-income taxpayers, and increase from 0% to 10% for lower-income taxpayers.

Dividends will be taxed at ordinary rates, which are set to increase. For 2012, income-tax brackets are 10%, 15%, 25%, 28%, 33% and 35%. For 2013, they could increase to 15%, 28%, 31%, 36% and 39.6%. The 10% bracket will go away.

McEowen notes, however, that there is a 3.8% “tack-on” under Obamacare for certain high-income taxpayers starting in 2013. That increases the top end of the capital gains tax to 23.8% and dividend tax to 43.4%.

All of this, of course, depends on what Congress does in January, and that depends on the outcome of the election. Since this was written before election day, predicting next year’s tax policies is impossible. However, McEowen says that if Barack Obama is reelected and the Democrats retain control of the Senate, expect to pay higher taxes across the board – income tax, capital gains tax, rents, dividends, royalties, payroll tax, etc.

So, Gunther says, now’s the time to act. If you haven’t already, sit down with your accountant and take a hard look at what your options are and plan accordingly.

Tax relief for drought-stricken ranchers

The Internal Revenue Code contains two provisions helpful to cattlemen affected by drought. Code Section 451(e) allows you to postpone reporting the taxable gain on the additional sales of any livestock for one year. Code Section 1033(e) allows tax postponement on the gain of breeding animals if they’re replaced within a period of time.

If they’re replaced by like-kind breeding stock, the period is four years, McEowen says. Those animals can also be replaced by non like-kind farm property such as machinery, but only within a two-year window.

Earlier this year, however, the IRS gave a one-year extension to the time producers can replace breeding stock and defer taxes on any gains from forced sales due to drought.

The relief applies to any operation located in a county, parish, city or district listed as suffering exceptional, extreme or severe drought conditions by the National Drought Mitigation Center during any weekly period between Sept. 1, 2011 and Aug. 31, 2012. This includes all or part of 43 states and also applies to any contiguous county.

That also means farmers and ranchers in these areas who suffered losses in 2008 and whose drought sale replacement period was scheduled to expire at the end of the year will now have until the end of 2013.

Planning is critical. “You’ve got to take the initiative, take advantage of what’s out there right now and get something done, or you’re leaving money on the table,” Gunther says.